The Lost War

Did the US just lose the trade war? It seems like a ludicrous question to ask at this time as the US just raised tariffs on China to increase pressure on the negotiation process. The accepted conventional wisdom is that the US has the stronger hand to play as China would suffer more from tariffs than the US. That sounds good on paper, but is that really true in a three dimensional world with moving parts and conflicting timelines?

In many a fight match up the audience can get a sense of shift in momentum during a fight and as this trade war just shifted gears I can’t help but wonder if the momentum has shifted in China’s favor.

Let’s start with the reason for the sudden tariffs. Those came about because the US side was surprised, surprised by China’s apparent withdrawal from previous commitments. At least that’s the public narrative that is spun. Unless you’re in the negotiation yourself it’s hard to know. Fact is Trump, Kudlow and team led the world believe that a trade deal was imminent. It wasn’t. This move to escalate was not planned, it happened because team Trump realized they couldn’t get the deal they wanted or expected.

Being surprised and being forced to be reactive to escalate does not indicate a position of strength, but rather a position of weakness. And by reacting with tariffs Team Trump may have actually weakened their own position. Why? Because of inflation, time, and pain.

Let’s start with inflation: Despite Donald Trump’s repeated claims that China will pay the tariffs it simply is not so. US businesses and consumers are paying for tariffs which causes consumer inflation on the one hand and margin compression on the other, and perhaps a mix of both depending on what can be passed on.

But conceptually it’s literally shooting yourself in the foot.


Reality via Goldman Sachs:

Consumers are already paying for the tariffs and soon a lot more.

With new tariffs in effect the impact will broaden out:

The Fed’s going to cut rates (as Trump’s demands) if inflation suddenly jumps by 0.5% per the scenario above? Not going to happen.Indeed in this scenario the Fed may be forced to raise rates. Bull market over. Recession coming. What a mess.

Think the numbers are outlandish? Consider the math $AAPL is now confronted with. According to JPM Apple needs as much as a 14% price increase on iPhones to offset headwinds from scope expansion of tariffs or eat it with margin compression:

No, the damage from tariffs will be measurable and real and it’s not a long term winning formula which brings me to the second consideration: Time.

Someone will blink and I suspect it will be the US side. Why? Because for Trump there’s an election to worry about. The Chinese don’t have an election to worry about and that puts the time pressure on Trump, not the Chinese. The Chinese will continue to intervene and yesterday they showed backbone and followed through on retaliation. But because the US election cycle clock is ticking Donald Trump cannot afford a trade war extending into the end of the year, especially if the consequences of such a protracted trade war would spill into the larger economy.

A protracted trade war and associated loss of confidence has not been accounted for in earnings estimates.

Which brings me to the third issue: How much pain is Donald Trump willing to take with a falling stock market that he views as his measure of success. Judging from the daily jawboning: Not very much. Overnight futures jumped as Trump started the optimism train again for a late June G20 meeting and even this morning he’s out with repetitive tweet storms regarding China desperately trying to project strength:

If only the Fed would cut rates we would win. Way to go to set the Fed to be the fall guy if things go bad. It’s the Fed’s fault if we lose the trade war with China. Of course, nothing is ever Trump’s fault. It’s the world that’s evil and Trump’s trying real hard to be the shepherd:

No, the frequency of tweets and erratic nature of the tweets as Jim Cramer called them this morning suggest Trump finds himself under sudden pressure given the big market thumping yesterday.

Again I ask: Why would the Chinese agree to a deal they view as disadvantageous? They’re not running against the clock here, Trump is. He may still have a few months, but delays of several months will bring about economic and financial market consequences the president can ill afford politically. And the Chinese know this.

Trade wars end when one or both parties are forced to cave on positions. That’s not happening yet and won’t happen with US stock prices only 5% off of the all time highs. And now with the latest bout the parties are being forced into corners. Neither can politically afford to look to cave to pressure and that sets the stage for a protracted trade war, one that the US may now look to lose. Why? Because Trump won’t get the deal he thought he’d get just a week ago. Instead he was goaded into raising tariffs and is now hurting US business and consumers in the process.

The upshot in all this: If the US caves sooner rather than later the price may be confined to the political, and result in a major relief rally, especially if tariffs are removed. What the specifics of any trade deal then are may not matter in the immediate aftermath. I’m sure Mr. Trump will present himself to be winner even if he got knocked out in the second round. After all, it’s the Fed’s fault.

But no trade deal and ongoing tariffs into the rest of the year? I think it’s fair to say markets have not priced that scenario in. Best hope somebody caves.

For the latest public analysis please visit NorthmanTrader. To subscribe to our market products please visit Services.

All content is provided as information only and should not be taken as investment or trading advice. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise. For further details please refer to the disclaimer.

Categories: Opinion

Tagged as:

22 replies »

  1. Northman,
    Don’t forget about the farmers who supported the buffoon in chief in 2016, and have been already hurting with the present tariff load. They’ll vote their pocketbooks if Trump doesn’t reverse course sooner rather than later. However, a war, as advocated by Chickenhawk in chief, John Bolton will make a sitting president more electable no matter how despicable he is. There is no control of reality anymore. I’m putting some on the sidelines. Nothing but lose-lose-lose on the horizon. Its the Dems election to lose, but they have figured out how to lose before. If they win, markets will still tank because a Dem may raise taxes and is seen as “adding uncertainty”. Zero confidence in the body politic.

  2. Sven, one of the dumbest articles you’ve ever written. As a fellow Canuck, I am ashamed of your lack of analysis, verging on a click bait / hit piece.

  3. The current low rates, and Powell’s promise not to raise them (plus POTUS’ call to lower then even more), are all suggesting to China’s central bank that they have room to stimulate without significantly disturbing the relationship between the USD and the Yuan. But if the Fed did raise rates, or at least stopped the narrative of keeping them low, then that would change.

    The consequences would be:
    – Fed takes the political blame (acceptable)
    – retail investors are “left holding” the equities proverbial “bag” (not unheard of)

    That would at least even the playing field for additional negotiations…

  4. China also controls their central bank, Trump doesn’t. I buy the narrative of Fed’s fault in the moment that they do not have any accountability and have caused almost every crisis with their decisions on rates and monetary policy. Trump should make the Fed accountable for their mistakes to the US citizens, who have never elected any member of Fed but are impacted by their policies.

  5. Great Perspective Sven 🙂 Your political timing argument makes sense and the Chinese news has been saying something very similar in their news. They definitely know what political/economic cards they are holding and Trump looks to be at a disadvantage. Also, it’ll be hard for Trump to back off the Tariff threats as he’ll loose major credibility. He’s convinced his voter base to take the pain to help him win and his elections depend on their continued trust in him.

  6. You don’t have much credibility when it comes to political analysis.

    After all, it was one of your “key” market predictions that Mueller would crater Trump… and we all know how that turned out. lol

  7. Sven, really enjoy your technical and economic analyses, but not so much the political commentary. This is because if Trump caves, we will have lost not only the immediate trade war, but will lose, likely for years, the trade war the Chinese have been conducting for decades. It’s just not acceptable for China to steal US intellectual property and technological and military secrets. Their theft undermines the security and economy of the US, and the Western world, in the long term.


This site uses Akismet to reduce spam. Learn how your comment data is processed.